Understanding the Wrap Transaction

Understanding the Wrap Transaction

By: Matthew J. Kirkpatrick, Esq. and Sierra N. Grandbois, Esq.

April 27, 2021

When the market heats up and individuals begin to feel priced out of the market, buyers look to get creative in how they can purchase a house. There are lots of ways to complete real estate transactions, various financing models and one that seems to be getting more traction these days is the wrap transaction. Maybe you went to a seminar recently and they discussed this transaction model. Maybe a seller or investor identified this type of real estate transaction. to show you how to buy or sell properties using a transaction called a wrap-around loan, or a wrap loan. The wrap transaction is often promoted as an alternative way to buy and sell properties when conventional lending does not accommodate the parties. While they can be attractive in some circumstances, they do come with considerable risks.

What is a wrap transaction?

It is a sale transaction which includes junior seller financing that covers the entire balance of the seller’s existing loan encumbering the property and some portion of the balance of the purchase price. It is called a wrap loan because the seller financing “wraps around” the existing loan. The buyer often pays the seller the mortgage payment of the existing loan as well as an additional amount to cover the balance of the purchase price. The buyer makes payments to seller, who takes a portion of that payment and then pays the existing loan. This allows the buyer to purchase the property when a conventional loan for the full purchase price which would consist of the existing loan as well as the seller’s equity in the property is not feasible.

Why would anyone want to use a wrap loan?

Wrap loans can be useful when the buyer has bad credit and is not able to obtain a loan from a conventional lender. It is also useful when the buyer needs to reduce their debt to income ratio for other purposes and does not want the loan to show on their credit. Perhaps the buyer and seller simply do not want to deal with the trouble of traditional lenders. A wrap loan could remove traditional lenders from the purchase and sale process. Another good reason a buyer may want to use a wrap loan is to take advantage of a seller’s low interest rate in a time when rates are increasing and therefore only pay market rates for the excess principal balance between the existing loan and the wrap loan.

What problems come up in wrap transactions?

Due on transfer clause – The first risk is that virtually all loans contain a due on transfer clause. These entitle the lender to accelerate the debt upon the transfer of title to the property. If the lender ever determines that the property has been sold and title has transferred, they are entitled to immediately demand full payment or buyer and seller risk foreclosure proceedings. If this were to come about, buyer would need to seek alternative financing to cover the balance of the existing loan in a short period of time.

Nonpayment by Buyer – In a wrap transaction, seller’s loan remains in place. Therefore, seller remains obligated under the loan. Seller is essentially loaning their credit to buyer for the amount of the existing loan. Sometimes the wrap transaction requires buyer to make their payment on the existing loan to a third party who then makes the payment to the existing lender. Unfortunately for seller, if an unscrupulous buyer fails to make payments, it may be too late for seller to catch up the existing loan payments by the time seller finds out.

Nonpayment by Seller – The buyer has risk that seller will accept buyer’s payments, but instead of taking a portion of the payment and forwarding it along to the existing lender, the buyer pockets the money. While it puts the seller’s credit at risk, buyer would be the one that loses the property as well as any payments that were made.

If you are considering a wrap transaction, the attorneys at BPE Law Group have decades of experience advising individuals, businesses, and investors on the use of wrap transactions and how to navigate them. If you are considering a wrap transaction, make sure to consult a legal professional to assist. Make sure to address contractually the loan payment obligations of the parties; application of extra payments; and who has the liability if the loan is accelerated by the lender.

The information presented in this article is not to be taken as legal advice. Every situation is different. If you are facing a legal issue of any kind, get competent legal advice in your state immediately so that you can determine your best options.

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